Third-party time

More and more people are piling into the UK’s litigation funding market – but could the shadow of cost liability turn them off?

In brief

Litigation has picked up since the financial crisis, but lack of funds means many claimants are seeking alternative sources of funding. Third-party litigation funding has proved attractive as an option, but its place in the dispute resolution world is still uncertain with some rules and regulations yet to be clarified.

While still a relatively new concept, third-party litigation funding has become mainstream in the past few years. Its increase in popularity and acceptance means that the funders out there are beginning to expand, with a number – including Vannin Capital and Harbour Litigation Funding – recently announcing that they had increased the amount of capital available to fund cases.

However the growth of the sector also means it is coming under scrutiny from government as the place of litigation funding in the legal market is questioned. A code of conduct introduced last year by the newly-established Association of Litigation Funders was welcomed as a way of streamlining standards in the industry.

Now, as cases funded by third parties come to resolution, the Government is also looking at where these businesses fit and what rules should apply to them.

The increase in capital is seen as a positive sign that the market is starting to mature. Nick Rowles-Davies, founding solicitor at Vannin Capital, says the fact that his company is not the only one to have raised extra funds is positive.

“It’s a sanity check for me as it means we’re in the right industry,” he comments. Vannin quadrupled its annual litigation fund from £25m to £100m this year.

An attractive market

At Harbour Capital, which recently raised £120m – double the amount of its previous capital raising in 2010 – head of litigation funding Susan Dunn says the increase in capital shows that investors want to put their cash into this asset class.

“I think it’s a sign of confidence by investors in those who have a track record,” she says.

US litigation funder Burford Capital is moving into the UK, through its recent acquisition of after-the-event (ATE) broker FirstAssist. Chief investment officer Jonathan Molot says he is not surprised the market is attractive, supported as it is by the Government and through initiatives such as the code of conduct.

James Delaney

Those involved in litigation funding believe the extra money in the sector is good for everybody. James Delaney, director at litigation funding broker TheJudge, says clients have benefitted from more price-driven competition as a result.

“The increase in capital has definitely aided the market particularly from the clients’ perspective,” says Delaney. “It also potentially places more pressure on funders not to engage so quickly in exclusivity periods which can be problematic for the clients. There’s more sources of funding for the clients, which puts pressure on what the funders have to do to win clients’ business.”

Funders say there are still more cases seeking funding than funders looking for litigation to support. Dunn estimates that Harbour Capital receives about 40 applications every month for funds, but commits money to only a handful of these.

“Being able to do it successfully is bloody difficult,” she points out. “We’re looking at things daily. We don’t succeed in all the cases that we fund. It’s a very challenging activity and it’s a long-term activity as well. You can only get good at things by doing a lot for a long time.”

Delaney thinks demand is higher at the lower-value end of the scale, with bigger cases being funded more readily.

“For smaller value cases there’s definitely a shortage of capital. The void is at the lower-value end,” he says. This, he says, is due to investors’ attention mainly being focused on the bigger returns possible from larger cases. Molot adds that while the percentage of profit to be made from smaller cases is not too different from that possible from large cases, there are more efficiencies to be found in the processing and handling of the case.

Continued growth

Those already in the market are confident that it will continue to grow. Dunn says many are trying to break in.

“There’s a lot of people who claim that they’re funders when they’re not. I think that’ll sort itself out eventually,” she thinks.

Molot agrees. “In the US and globally there are many people who claim to be a litigation funder, more than are actually in the funding market,” he says. He thinks that the code of conduct will help a little. “It helps ensure that a litigant or law firm looking for funding doesn’t waste its time.”

The code of conduct last year was welcomed, but currently only a handful of litigation funds are actually signed up to it and, as Rowles-Davies notes, “it’s not yet a chartermark or a quality standard”.

The Association of Litigation Funders remains voluntary, and while Rowles-Davies also says that an organisation presenting itself as a funder should be a member, he welcomes the fact that membership is not obligatory.

“I think it’s right that it’s voluntary, I don’t think statutory regulation would work in this sector,” he says.

However there is need for clarification about aspects of the way litigation funding works. Case law is helping in some respects but a recent report produced by the Civil Justice Council focusing on contingency fees and damages-based agreements (DBA) has also weighed in. DBAs are set to be introduced in April.

Although the report is largely concentrated on personal injury cases, the most common type of cases which use contingency fees, it also discusses the issue of adverse costs in non-personal injury cases.

The 1998 case of Hodgson v Imperial Tobacco ensures that lawyers acting on a contingency fee agreements (CFA) basis are immune from adverse costs orders. The Civil Justice Council contingency fees working party suggested that “it would be consistent and sensible to extend the same immunity to lawyers acting on a DBA”.

Picking up the costs

Third-party litigation funders can also be involved in cases on a DBA or CFA basis. In 2005, the Court of Appeal ruled in the case of Arkin v Borchard Lines & Ors, saying that a funder should be potentially liable for the opposing party’s costs to the extent of the funding provided.

Lord Justice Jackson raised the Arkin case in the working party’s terms of reference.

“If the lawyer stands to receive a share of the proceeds of the litigation, then the question arises whether – if the client fails to pay – the lawyer should be liable for adverse costs on Arkin principles. If so, there is the further question of whether CPR [Civil Practice Rule] 48.2 requires amendment or is sufficient as it stands. If there is no such liability, then litigation funders may be able to bypass their existing liability for adverse costs by buying up law firms and funding litigation through the mechanism of DBA’s,” he wrote.

The working party reasoned in their report that there was no practical distinction between a CFA and DBA, and therefore lawyers acting under a DBA should be immune from adverse costs under the Hodgson principles.

But they disagreed with Jackson LJ’s suggestion that a litigation funder would be able to gain the same immunity by working through a law firm model.

“If the immunity survives as we believe it should, we doubt that a litigation funder would be able to bypass its existing liability for adverse costs by setting up an ABS and funding the case through the ABS. The ABS will be seen for what it is. It will be known to have funded the costs in the case and will itself consequently become subject to Arkin principles. Thus the fact the ABS conducts the claim under a DBA is not in point – it is the funding by the ABS which would ensure that Arkin continued to apply,” the report says.

Peter Smith, managing director of FirstAssist Legal Expenses Insurance and a member of the working party, says while “it’s abundantly obvious that funders would prefer not to be held liable” the working party’s main concern was to ensure that DBAs work when introduced.

“An alternative would be to ask for an abolition of the law of champerty,” he says, revealing that such a recommendation was “briefly considered” before being dismissed as wide of the terms of the working party.

Eyes wide open

Delaney agrees that there should be a distinction between solicitors and funders. “At the moment funders are accustomed to the Arkin principles. They recognise that there’s a potential threat, they’re going into it with their eyes open,” he says.

He adds that adverse costs in large cases are usually covered by ATE insurance, with the premiums payable covered by the expected damages. And, as Smith points out, ATE insurance rarely fails except in occasional cases of fraud, meaning funders will most likely avoid having to shell out for adverse costs from their own pockets.

“The cases tend to be so big in terms of the claim value that the clients are paying for the premiums from the damages. I’m not really sure it’s an issue other than the political debate. I think the funders accept that they have that potential liability. They’ve accepted it in terms of their modelling,” Delaney says.

Dunn is more cautious in her assessment of the report.

“I think the report makes an interesting read. There are some exceptions which have been overlooked which would lead to big losses for the defendant if it were reliant on assuming that the claimant was good for the money and he was then not to be,” she says.

“There’s only going to be a few cases where there’s a gap to be fallen down but prima facie is it correct if you’re a law firm funding a case you don’t have the liability whereas as funder you do? What will be the reality when that gap is fallen down? I just don’t really understand the distinction,” she continues.

According to Dunn, it will be key to see how the recommendations are implemented and how they are dealt with by the funders’ code of conduct.

The working party’s report and its decision to consider how the introduction of DBAs will impact litigation funding is another sign that it is now firmly part of the litigation landscape in the UK. The arrival of more funders to take the risks involved for the potential rewards is now a certainty.